I warned many about the coming crisis, long before it happened, on many occasions and in many places, even at the World Bank. They did not want to listen and that´s ok, it usually happens, but what is not ok, is that they still do not seem to want to hear it. “We can easily forgive a child who is afraid of the dark; the real tragedy of life is when men are afraid of the light.” (Plato: 427 BC – 347 BC)

Thursday, May 8, 2003

“In a world that preaches the worth of the invisible hands of the market, with its millions of mini-regulators we find it so strange that the Basel Committee delegate, without any protest, so much responsibility in the hand of so very few and so very fallible credit rating agencies”

“Warning, excessive banking regulations from the Basel Committee can be very dangerous for the development of your country”

Friday, May 2, 2003

As I know that some of my comments could expose me to clear and present dangers in the presence of so many regulators, let me start by sincerely congratulating everyone for the quality of this seminar. It has been a very formative and stimulating exercise, and we can already begin to see how Basel II is forcing bank regulators to make a real professional quantum leap. As I see it, you will have a lot of homework in the next years, brushing up on your calculus—almost a career change.

But, my friends, there is so much more to banking than reducing its vulnerability—and that’s where I will start my devil’s advocate intrusion of today.

Regulations and development.
The other side of the coin of a credit that was never granted, in order to reduce the vulnerability of the financial system, could very well be the loss of a unique opportunity for growth. In this sense, I put forward the possibility that the developed countries might not have developed as fast, or even at all, had they been regulated by a Basel.

A wider participation.
In my country, Venezuela, we refer to a complicated issue as a dry hide: when you try to put down one corner, up goes the other. And so, when looking for ways of avoiding a bank crisis, you could be inadvertently slowing development.

As developing sounds to me much more important than avoiding bank failures, I would favor a more balanced approach to regulation. Talleyrand is quoted as saying, “War is much too serious to leave to the generals.” Well, let me stick my head out, proposing that banking regulations are much too important to be left in the hands of regulators and bankers.

Friends, I have been sitting here for most of these five days without being able to detect a single formula or word indicating that growth and credits are also a function of bank regulations. But then again, it could not be any other way. Sorry! There just are no incentives for regulators to think in terms of development, and then the presence of the bankers in the process has, naturally, more to do with their own development. I believe that if something better is going to come out of Basel, a much wider representation of interests is needed.

A wider Scope.

I am convinced that the direct cost of a bank crisis can be exceeded by the costs of an inadequate workout process and the costs coming from the regulatory Puritanism that frequently hits the financial system—as an aftershock.

In this respect, I have the impression that the scope of the regulatory framework is not sufficiently wide, since the final objective of limiting the social costs cannot focus only on the accident itself, but has also to cover the hospitalization and the rehabilitation of the economy. From this perspective, an aggressive bank, always living on the edge of a crisis, would once again perhaps not be that bad, as long as the aggressive bank is adequately foreclosed and any criminal misbehavior adequately punished.

On risks.

In Against the Gods Peter L. Bernstein (John Wiley & Sons, 1996) writes that the boundary between the modern times and the past is the mastery of risk, since for those who believe that everything was in God’s hands, risk management, probability, and statistics, must have seemed quite irrelevant. Today, when seeing so much risk managing, I cannot but speculate on whether we are not leaving out God’s hand, just a little bit too much.

If the path to development is littered with bankruptcies, losses, tears, and tragedies, all framed within the human seesaw of one little step forward, and 0.99 steps back, why do we insist so much on excluding banking systems from capitalizing on the Darwinian benefits to be expected?

There is a thesis that holds that the old agricultural traditions of burning a little each year, thereby getting rid of some of the combustible materials, was much wiser than today’s no burning at all, that only allows for the buildup of more incendiary materials, thereby guaranteeing disaster and scorched earth, when fire finally breaks out, as it does, sooner or later.

Therefore a regulation that regulates less, but is more active and trigger-happy, and treats a bank failure as something normal, as it should be, could be a much more effective regulation. The avoidance of a crisis, by any means, might strangely lead us to the one and only bank, therefore setting us up for the mother of all moral hazards—just to proceed later to the mother of all bank crises.

Knowing that “the larger they are, the harder they fall,” if I were regulator, I would be thinking about a progressive tax on size. But, then again, I am not a regulator, I am just a developer.

Conspiracy?
When we observe that large banks will benefit the most with Basel II, through many risk-mitigation methods not available to the smaller banks which will need to live on with Basel I, and that even the World Bank’s “Global Development Finance 2003” speaks about an “unleveling” of the playing field for domestic banks in favor of international banks active in developing countries, I believe we have the right to ask ourselves about who were the real negotiators in Basel?

Naturally, I assume that the way the small domestic banks in the developing countries will have to deal with these new artificial comparative disadvantages is the way one deals with these issues in the World Trade Organization, namely by requesting safeguards.

Credit Ratings

Finally, just some words about the role of the Credit Rating Agencies. I simply cannot understand how a world that preaches the value of the invisible hand of millions of market agents can then go out and delegate so much regulatory power to a limited number of human and very fallible credit-rating agencies. This sure must be setting us up for the mother of all systemic errors.

The Board As for Executive Directors (such as myself), it would seem that we need to start worrying about the risk of Risk Managers doing a de facto takeover of Boards—here, there, and everywhere. Of course we also have a lot of homework to do, most especially since the devil is in the details, and risk management, as you well know, has a lot of details.

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Why don't bank regulators get it?

The less the perceived risk of default is, and the higher the leverage allowed, the greater the systemic risk.

My huge problem!

Q. "If Kurowski is right, why are his arguments so ignored? A. If I had argued that the regulators were 5 to 10 degrees wrong, I would be recognized, but since I am arguing they are 150 to 180 degrees wrong, I must be ignored.

The deafening noise of the Agendas

The fundamental reasons why it is so hard to advance the otherwise so easy explainable truth of this financial crisis, is because of the deafening noise of the Agendas…

On one side, we have the "progressives" who want to put all the blame on capitalistic banksters, and, on the other, the "conservatives" who want to blame the socialistic government sponsored enterprises GSEs of Fanny Mae and Freddy Mac.

For any of both sides accepting the fact that it was mostly a regulatory failure of monstrous proportions would seemingly be a highly inconvenient truth that would not help them to advance their respective agendas.

You tell me!

What is more dangerous in a systemic way, that which is perceived as risky or that which is perceived as not risky? Right!

How can the Basel Committee be so dumb?

Systemic risks is about something that can become as big so as to threaten the system… and our bank regulators in the Basel Committee are incapable or unwilling to understand that what has the largest possibilities of growing as big so as to threaten the system is what is perceived as having little or no risk, not what is perceived as risky… which makes their first and really only pillar of their regulations, that of capital requirements of banks that are lower when perceived risks are lower… so utterly dumb!

We must stop our gullible and naive financial regulators from believing in never-risk-land.

The stuff that bonuses are made of

Whenever a credit rating corresponds exactly to real underlying risk neither borrower nor lender loses but the intermediary cannot make profits… it is only when the credit ratings are too high or too low that those margins that can generate that profitable stuff that bonuses are paid for exist.

What were they thinking?

The default of a debtor is about the most common, natural and even benign risk in capitalism, so it is so hard to really get a grip on what was going around in the minds of the regulators when they decided to construe capital requirements for banks based exclusively on discriminating against that risk as it was perceived by some credit rating agencies.

Day by the day it is becoming more relevant... scary!

This I published in November 1999... Read it!

The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of the OWB (the only bank in the world) or of the last financial dinosaur that survives at that moment.

Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversify risks, is to create a tax on size.”

This I wrote, October 2004, as an Executive Director of the World Bank

We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.

Regulatory hubris

In a world with so many different risks, some naïve gullible and outright stupid regulators thought everything would be fine and dandy if they just had some few credit rating agencies determine default risks and then gave the banks great incentives, by means of different capital requirements, to follow those credit risk opinions.

On bs.

When experts bs..t the world that’s bad news, but when experts allowed themselves to be bs..ted by bs..ing experts that’s is when the world goes really bad.

My most current proposal on the regulatory reform for banks

Fire the teachers!

They were supposed to teach the world prudent risk-taking and instead they taught it imprudent risk-aversion.

The deal!

This was the deal! If you convinced risky and broke Joe to take a $300.000 mortgage at 11 percent for 30 years and then, with more than a little help from the credit rating agencies, you could convince risk-adverse Fred that this mortgage, repackaged in a securitized version, and rated AAA, was so safe that a six percent return was quite adequate, then you could sell Fred the mortgage for $510.000. This would allow you and your partners in the set-up, to pocket a tidy profit of $210.000

Calling it quits?

A world that taxes risk-taking and subsidizes risk adverseness is a world that seems to want to lie down and die

Let´s neutralize the wimps!

If we are to keep on using Basel methodology for establishing the minimum capital requirements for banks, beside better risk weights, we must demand it also uses “societal purpose” weights.

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Silly bank regulators!

What other word could describe a bank regulatory system designed exclusively to avoid bank crisis as if that is the only purpose of banking. You might just as well order the kids to stay in bed all life so as to diminish the risk of them tripping.

The minimum capital requirements of Basel that are based on default risks as measured by the credit rating agency amount to a dangerous tax on the risk, the oxygen of development.

Blindly focusing on default and leaving out any consideration that a credit with a low default risk but for a totally useless or perhaps even an environmentally dangerous purpose is much more risky for the society than a credit with a higher default risk destined to trying to help create decent jobs or diminish an environmental threat, is just silly.

But do I have to be disrespectful and call them silly? Well, individually perhaps they are not, but, as a group, bank regulators are so full of hot air that someone has to help them to puncture their cocoon balloon and let them out.

Breathe!

I’m going to third-pillar what?

By now the desperate bank regulators are throwing at us the third pillar of their Basel regulations which implies the need that we ourselves privately monitor our banks. Great, in my country, a couple of decades ago, I did just that and had a fairly good grip on whom of my banker neighbors were good bankers and whom to look out for.

But sincerely what am I supposed to do know when about 50 per cent of the retail deposits in my country are in hand of international banks (Spain) and that might be losing their shirt making investments in subprime mortgages in California?

Tragedy!

It is very sad when a developed nation decides making risk-adverseness the primary goal of their banking system and places itself voluntarily on the way down but it is a real tragedy when developing countries copycats it and fall into the trap of calling it quits.

Development rating agencies?

A bank should be more than a mattress!

When considering the role of the commercial banks should not the developing countries use development rating agencies instead of credit rating agencies?

Clearly more important than defending what we have is defending what we want to have.

What do we want from our banks?

Over the last two decades we have seen hundreds if not thousands of research papers, seminars, workshops conferences analyzing how to exorcize the risks out of banking; and if in that sense the bank regulation coming out from Basel was doing its job; and centred around words like soundness, stability, solvency, safeness and other synonyms. Not one of them discussed how the commercial banks were performing their other two traditional functions, namely to help to generate that economic growth that leads to the creation of decent jobs and the distribution of the financial resources into the hands of those capable of doing the most with it.

At this moment when we are suddenly faced with the possibilities that all the bank regulator’s risk adverseness might anyhow have come to naught, before digging deeper in the hole where we find ourselves fighting the risks, is it not time to take a step back and discuss again what it is we really want our commercial banks to do for us? I mean, if it is only to act as a safe mattress for our retail deposits then it would seem that could be taken cared of by authorizing them only to lend to the lender of last resort; but which of course would leave us with what to do about the growth and the distribution of opportunities.

About Me

We are suffering from more and more answers than questions begging for them, and so I work on the latter.
Read it all in my one and only book!"Voice and Noise"
Pssst... so few have read this book so it is slowly turning into a collector item (I do not say a "cult"... yet) and so you might benefit from getting your very own copy now.